April 18, 2014

CBO Estimates Potential Damage from Fiscal Cliff

  • The national debt has grown significantly in recent years due to rising annual deficits. A deficit occurs in any year the government spends more...

The Congressional Budget Office (CBO) has once again warned lawmakers of the potential economic damage of failing to act on the “fiscal cliff” -- the combination of automatic spending cuts and expiring tax cuts scheduled to begin in January.

If these provisions in current law are all permitted to go into effect, CBO estimated in a report last week, real gross domestic product (GDP) would drop by 0.5 percent in 2013 and the unemployment rate would rise to 9.1 percent in the fourth quarter of that year. CBO estimates that economic growth would later increase, however, and unemployment would decrease to 5.5 percent by 2018.

The new report is called “Economic Effects of Policies Contributing to Fiscal Tightening in 2013.”

If some or all of the fiscal cliff components were removed, economic output and employment could improve over the short term from what they otherwise would be. The report provides two sets of calculations on these economic effects. One emphasizes how avoiding various cliff components would boost GDP. The other calculations offer a “bang per buck” comparison by dividing the GDP effects by the budgetary cost of the policies. Both sets of calculations can help policymakers develop a more thoughtful and effective approach to deficit reduction.

Changing the components of the fiscal cliff could help the economy over the short term. The budget office continues to caution, however, that alternative measures providing a comparable amount of deficit reduction over the coming decade would be necessary to prevent long-term harm to the economy.

The CBO states that “a continued surge in federal debt during the rest of this decade and beyond would raise the risk of a fiscal crisis (in which the government would lose the ability to borrow money at affordable interest rates) and would eventually reduce the nation’s output and income below what would occur if the fiscal tightening was allowed to take place as currently set by law.”

The CBO last week also released another report called “Choices for Deficit Reduction.” It reviews the magnitude and causes of the federal government’s budgetary imbalance and provides an update on possible options for “bringing spending and taxes into closer alignment.”